Private equity tax questions for Mitt Romney

FORTUNE — If President Obama’s supporters want to attack Mitt Romney over his time at Bain Capital, there may be a more productive tact than fruitlessly searching for illegal tax dodges in old investor presentations. Make it about tax policy.

Romney today indicated an increased willingness to get specific on his private equity history, through an op-ed in The Wall Street Journal. But he has remained entirely silent on the myriad of unfair financial breaks afforded to private equity firms and their executives. As president, would he make efforts to right such wrongs, or would he endorse a status quo that benefits former colleagues?

Here are three relevant issues:

1. Carried interest. This is the percentage of a private equity fund’s investment profits that flow to the actual fund managers. It’s typically around 20%, although Bain Capital has a history of charging 30%.

So for every $1 million that a private equity fund earns, between $200,000 and $300,000 go to the firm’s individual partners. But this money is not taxed at ordinary income rates, which would be around 35% for most private equity professionals. Instead, it’s taxed at the 15% capital gains rate (which is expected to climb to 20% in 2013, as the Bush tax cuts expire). Capital gains treatment is designed as a reward for taking risk, but the only risk taken here is by third-party investors who put up the actual investment capital. For more detailed arguments, go here and here.

Romney said during his last presidential run that carried interest should remain a capital gain, but this time around has steadfastly refused to reaffirm or reject that position. And he’s had plentyofchances. For his part, Obama is on record as supporting a change to carried interest taxation.

2. Corporate interest deductions. Private equity executives love to talk about how they identify operational inefficiencies at portfolio companies, as Romney did in today’s column. Less talked about is how private equity structures its purchases in a way that significantly stacks the deck in its favor, even if such measures fail to work. And they are able to do so thanks to the tax code.

Specifically, private equity funds typically only put up between 40%-70% of a company’s purchase price. The rest comes from banks, in the form of debt that gets added to the company’s balance sheet. It’s kind of like trying to buy a house by asking the house itself to assume responsibility for paying the mortgage. But the company receives a 100% deduction on monies that get put toward interest payments, even if the company takes on even more debt to pay its PE sponsors a “dividend.”

President Obama suggested a reduction in corporate interest deductions back in February, as part of a broader corporate tax reform framework. He did not, however, specify by what percentage the deduction should be lowered. Romney has been entirely silent on the matter, and it is not addressed in his economic plan.

But a firm like Bain Capital doesn’t actually need private equity management fees to keep the lights on, because it has all sorts of other cash-generating businesses (hedge funds, venture capital funds, etc.). So its partners waive their management fees irrevocably, and have that money flow directly into the actual investment fund (Bain’s partners typically contribute between 10% and 15% of total fund capital themselves, so this funds a portion of that). By doing so, they don’t pay any tax on the management fee until (and unless) the fund returns a profit. And, at that point, it’s in the form of carried interest (i.e., capital gains).

Bain and certain other firms justify this aggressive method by pointing to IRS ruling 93-27, and tax attorneys I’ve spoke to differ on the legitimacy of such reliance, and on the broader validity/fairness/etc. of such tax treatment. What they do agree on, however, is that the IRS has allowed such activity to continue unabated. Romney should be asked if he believes private equity professionals should be able to escape paying ordinary income taxes on management fees, so long as those fees get put “at-risk.” Or if he thinks Congress should specifically prohibit the practice. Same question for Obama.

I sent an email to a Romney campaign spokeswoman about each of the three tax issues, but she has not yet responded.

Let me reiterate: I am not accusing Romney of illegally dodging taxes, since the only way we’d really know that is by viewing more of his tax returns (which, for the record, I believe he should release). But I am saying that he has benefited from certain legal tax rules that, in some cases, should be changed. And he should make his positions on those policies clear.

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